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Morningstar | BAX Updated Forecasts and Estimates from 27 Nov 2018

Baxter’s supply disruption issues seen previously continued to cause problems during the third quarter and will likely become a more prolonged challenge for the company to remediate. We plan to lower our top-line forecast for this year and 2019 in our model, but the current dynamic doesn’t dramatically shift our long-term thinking for the business. Our operating margin forecast is still in line with management’s 17.1% to 17.3% outlook. Therefore, we expect to leave our fair value estimate and narrow moat rating in place. Management lowered its year-end revenue growth forecast by approximately 100 basis points as stronger performance in the pharmaceuticals, advanced surgery, and acute therapies segments is dragged down by the ongoing weakness in the medication delivery and clinical nutrition segments. A lower tax rate and ongoing efficiency efforts should help push year-end adjusted EPS to between $2.98 to $3.00, at the high-end of management’s previous outlook.

The medication delivery and clinical nutrition segments posted weaker-than-expected results, with a constant-currency sales decline of 3% and 2%, respectively. The previously reported issues in both of these businesses have taken longer to correct than management originally anticipated, which has led to some leadership changes according to management. Management noted a number of issues, including previous supply constraints moving customers to alternative and competitor solutions in small-volume bags and unexpected inventory adjustments as supply improved in large-volume bags. Although we expect these issues won’t be rapidly fixed, we still anticipate a gradual recovery in these segments over the coming quarters.

Most of Baxter’s other business lines continue to perform within our expectations. Baxter’s dialysis segments--including both its renal care and acute therapies segments--continue to post stable performance with previous quarters at 3% and 10% constant-currency growth, respectively, during the quarter. Resilient cyclophosphamide sales and gains from the Claris injectables business have bolstered performance in the pharmaceuticals segment, which witnessed 5% growth.

We still think acquisitions will play a central role in Baxter’s attempts to focus the business on less commoditized product categories and improve overall profitability. Based on management commentary, the company seems to be evaluating a number of acquisition opportunities, including large businesses as well as categories outside of Baxter’s core operations. This year's unexpected weakness could be making management more desperate for new growth avenues, which may increase the odds of an announcement sooner rather than later.